Afghanistan: Wealthy But Unprepared

Afghanistan’s natural resources require a well-planned, long-term strategy. Can it come up with one?

By Andong Peng and Richard Ghiasy for The Diplomat

July 13, 2014

The pending outcome of the Afghan presidential election run-off on June 15 will decide a host of measures that will guide the country’s future development. While the presidential candidates have largely been opaque as to the methodology of their many and bold promises, it is generally assumed that the vote will usher in a new era. Where the Karzai Administration allocated the lion’s share of its efforts to security, the next administration will have to commit to economic development. The country’s endowment of natural resources is eyebrow-raising: by some measures Afghanistan has one of the highest natural resources per capita ratios in the region.

While Afghanistan does live in the shadow of regional giants such as Turkmenistan’s gas and Iran and Uzbekistan’s oil exports, it is still relatively resource-rich, with 22 barrels of oil equivalent (boe) per capita, in line with its neighbor Pakistan and ahead of its South Asian peers. Moreover, its hydrocarbon basins are under-explored by comparison. In the mining sector, copper leads the way in potential resources, far ahead of others in the region, positioning the country well vis-à-vis economic giants such as China. The Heart of Asia, as Afghanistan is also increasingly known, also contains a wide array of rare earth elements (REE). Currently, China has a firm grip on the world supply of these minerals, which are essential to the manufacture of mobile phones, computers, batteries, lasers and a host of other modern technologies.

But will the new Afghan leadership choose the extractive industry to spearhead economic development? And will they do so intelligently? The country has one high profile mining project, Mes Aynak, which is (still) in the early stages of development under Chinese auspices. In addition, there is one other major mining project, the Indian owned iron ore deposit at Hajigak, as well as a number of prospects across the non-ferrous sector and, on the Turkmenistan border, natural gas and oil.

Perhaps surprisingly, in modern history Afghan governments have never had a clearly discernible strategy to harness these resources, and certainly not for the long-term public good. Today, ministers talk about the country’s commitment to the private sector, and the Chinese involvement at Aynak and India’s at Hajigak have been much heralded. Yet any country at the formative stage of development must have a plan that extracts the maximum value for its people. A fair number of the decisions made at the top do not deliver these objectives. Aynak has hit a number of delays, and Hajigak’s extractive pace is not exactly exemplary either. Moreover, the government has been reduced to a marginal role in regulation, instead of playing a proactive part in resource development. Lastly, it is unclear how and when the revenues of these projects, when they materialize, will be utilized. This is clearly an indicator of mismanagement.

Structurally, it is something of an oddity that the Afghan government has pursued the use of a tax & royalty (T&R) system instead of a production sharing contract (PSC) arrangement with the Chinese and Indians – even in its oil and gas sectors. While T&R is more common in mining, in the oil and gas space it is the mark primarily of developed economies, and for good reason – they rely on a stable investment environment and legal infrastructure. PSCs were developed specifically for those times when risk is higher, in order to protect contractors and encourage investment; they also have the benefit of keeping notional ownership of the resource in the country’s hands rather than in those of the private company. PSCs are specific, binding legal frameworks that are not subject to changing legal developments and the whims of politics – which is critical for encouraging foreign companies to operate, but also in bringing the benefit of stability to the host country. The imposition of T&R appears to be a short-sighted transplant of U.S. norms into a country that cannot use them properly. Afghanistan must switch its fiscal terms to something more appropriate, if it wants to manage the nation’s incredible resource endowment properly.

Moreover, Afghanistan currently has no plan to build its own capacity in these industries. Ministers say that the private sector will be encouraged, but the skills base is unclear. The government cannot leave to private domestic capital what it should be doing itself. A national mining company should be a priority. The benefits of a state-owned enterprise (SOE) are numerous. It provides for the high-profile public ownership of national resources, a specific vehicle for capacity development in a given industry, particularly in the extractive industries, and it also helps create a stable platform for revenue generation that can be sustainable beyond the immediate reserve life of existent assets.

True, SOEs are often not the most efficient corporations – China’s CNPC for instance employs 1.7 million people while its U.S. competitor ExxonMobil uses just 100,000 – but that can provide a transitional benefit of employment and skills dissemination. And looking across the Asian landscape, there are plenty of efficient, sustainable SOEs that are doing a fine job for their countries, such as CNPC, Sinopec and CNOOC in China, PTTEP in Thailand, and Petronas in Malaysia. Many are considered world-class companies, and even the likes of Indonesia and Vietnam are following suit.

It might be argued that Afghanistan simply does not have the wherewithal to build an effective national corporation for mining or oil and gas. This is partly true in the short-term – Afghanistan starts from a state of development far behind even China or India several decades ago. The legal and management infrastructure are non-existent and the endemic corruption could end up being focused on entities such as an SOE. In the meantime then, the government must consider how to protect the potential revenues from projects such as Aynak, and make sure that corruption aside, this windfall is not myopically siphoned into spending plans which are wasted away.

Instead, the government should seek to build a national fund, equivalent to the sovereign wealth funds that have emerged in the last decade from Europe to Asia. This should have a specific remit to manage the capital from extraction and see the proceeds distributed evenly when needed. Again, one could argue that Afghanistan lacks the environment for adequate supervision, but many aid providers could be willing to give expertise. A nation such as Norway, suitably neutral and experienced (it has the world’s largest oil fund) might well be willing to set this up for free and help manage the capital as a sort of trustee until the situation improves in Afghanistan.

There are many options for the incoming administration to pursue, and even projects that have notionally been signed away can still be restructured. But it is important that whatever plan emerges, it must create social buy-in and energize the population in recognition of something that exists for the long-term good. Fiscal terms should be structured in a way that recognizes sovereignty, revenues must be protected and managed professionally, and a national entity must eventually be built which provides hope to ordinary people, acting as a magnet for investment and skills. Security and transportation of mineral wealth are a challenge indeed, but can be overcome if the political will is there.

In the region there are plenty of examples that Afghanistan can look at: Kazakhstan has managed to develop its resources in an equitable way, and Mongolia in a more populist form. But reform starts at home, and the new administration needs to have a clear position on how best to use the resources of this resilient but long-suffering nation. It is a decisive determinant of the nation’s long-term stability.

Andong Peng is a researcher at Tsinghua University’s School of Public Policy and Management. His area of focus includes Chinese foreign policy and communications. Richard Ghiasy is a research fellow at the Afghan Institute for Strategic Studies (AISS) in Kabul, Afghanistan.